Treasury rates stop rapid ascent… for now

Last week, the yield on the ten year US Treasury decreased by 4 bps from 2.53% to 2.49%. Yields held steady as comments from the Fed indicated that stimulus measures would likely continue into the near future.

The yield on the ten year US Treasury has increased significantly, from 1.63% in early May to approximately 2.50% currently, and is at its highest point since mid-2011.

Treasury yields matter because MLPs can be rate-sensitive instruments and an increase in Treasury yields could push investors to require more yield out of riskier investments such as MLPs.

Investors who hold master limited partnership (MLP) stocks often monitor interest rates on Treasury bonds. This is because many investors hold MLP stocks for the distribution or “yield” component of the securities. US government Treasury yields are relevant because if rates on the bonds increase, investors should expect rates on MLPs to theoretically increase as well. This is because many view US Treasurys as one of the safest yielding investments in the financial universe, and if the rates on Treasurys increase, the yield required from MLPs (and all other yield instruments) should also theoretically increase. When the yield on MLPs increases, the price and valuation of MLPs decrease.

Additionally, when yields on instruments such as Treasurys decrease, it also pushes investors seeking current income into other instruments such as corporate bonds and MLPs. Therefore, as Treasury yields decrease, yields across the bond sector and higher dividend stocks such as MLPs also tend to decrease.

The yield on the ten year Treasury has been consistently on the rise since early May when it was trading at around 1.65%, compared to current levels of ~2.50%. The rate on the ten year Treasury is the highest it has been since mid-2011.

In the context of a longer time period, Treasury yields had been close to all-time lows for awhile, though recently yields have backed up significantly. The below graph shows historic yields on the ten year Treasury from the beginning of 2001 to present.

The low yields over the past few years have mostly a consequence of the Federal Reserve pumping money and liquidity into the financial system. However, in June Fed Chairman Ben Bernanke commented that the Fed’s stimulus program could end as strength returns to the economy. The markets had reacted negatively to those comments, but just last week officials from the Fed further clarified that curtailments to stimulus measures would likely not come in the short-term. The below graph shows the yields on the Alerian MLP Index versus ten year Treasury yields.

Except for the period of the financial crisis, where investors pulled money out of riskier investments such as equities (which MLPs are) and poured it into cash and Treasuries, MLP yields have often moved directionally the same as Treasury yields.

Last week, the yield on the ten year Treasury was roughly flat, which was a neutral for MLPs. However, over the past several weeks, the yields on Treasury instruments had increased to the highest points in over a year which was a negative medium-term catalyst for the rate-sensitive MLP sector. Lastly, from a longer-term perspective rates remain relatively low which has resulted in a long-term positive for MLPs. If rates eventually rise for example to pre-recession levels of 4-5%, it could be a negative for MLPs and the Alerian MLP Index (AMLP). Major names in the index include Enterprise Products Partners (EPD), Kinder Morgan Energy Partners (KMP), Magellan Midstream Partners (MMP), and Plains All American Pipeline (PAA). Therefore, owners of MLPs should be aware of rate movements and how they affect MLPs.